Changeable economics of sluggish freight and a fiscal cliff

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The current and near-term state of U.S. economy remains, and rightfully so, a concern for fleet owners given what transpired with freight in the third quarter and what may or may not happen to economic growth in 2013.

In a third-quarter preview report issued today on air and surface freight conditions, analyst Peter Nesvold of Jefferies reported that “freight decelerated markedly during 3Q :12. ... After no fewer than nine earnings guide-downs or misses over the past month in transports [stocks], it likely comes as little surprise that freight flows during 3Q:12 decelerated meaningfully from 2Q.

“Demand in July and August was unseasonably weak,” he continued, “as illustrated by a parade of negative earnings announcements across our coverage [of logistics and trucking firms].

“We can’t remember a quarter in which so many companies lowered guidance, at least outside of the period immediately following the U.S. financial crisis,” stated Nesvold. “This was a notable departure from the relatively stable trends in the first half of the year, during which generally mild YoY [year-over-year] volume growth tracked historically seasonal trends.”

He pointed out that Jefferies’ 3Q channel checks indicate that the U.S. industrial economy underwent a “significant wave of inventory destocking during August. “Several contacts cited ‘what if’ concerns about the implications of the January 1st [2013] Fiscal Cliff [being triggered by inaction by Congress].”

The term “Fiscal Cliff” refers to enactment of a large reduction in the federal budget deficit that would slow down the economy if specific laws are allowed to automatically expire or go into effect at the beginning of 2013.

Nesvold said that while most of the contacts agree that the “probability of an extreme outcome [with the Fiscal Cliff] is low, the consequences of such a scenario would be severe, such contacts said it would be easier to restock in January after an ‘all-clear’ signal [on the Fiscal Cliff] than it would be to liquidate inventories in a negative GDP environment.

To this end,” he noted, “one might argue that the U.S. economy is already feeling at least some of the consequences of the Fiscal Cliff.”

The upshot, Nesvold said, is that on a year-over-year basis, there have been “generally flattish to down volumes across most transportation modes, broadly speaking, for 3Q:12.”

He advised that Jefferies’ macroeconomic tracking of weekly diesel-fuel consumption (which is done “because there’s a strong relationship between diesel consumption and industrial production as well as actual truck freight volume”) also reveals much about the state of freight.

“The most recent datapoint on weekly diesel consumption, the week of Sept. 21, now shows demand down 3.0% YoY, which marked a slight improvement on the previous week’s 4.9% YoY dip,” Nesvold advised. “Nevertheless, our diesel tracker is currently down an alarming 9.2% YoY on a six-week moving average basis-- its weakest YoY reading since the week of Feb. 26, 2010.

“The deterioration in diesel consumption during 3Q suggests a severely weakened economy, which is reflected in lower industrial production and the aforementioned growing 3Q guide-downs,” he observed. “Diesel consumption is likely to remain under pressure in the coming weeks as YoY comps get tougher in late September/early October."

As to what’s behind freight slowing, Nesvold rounded up the usual suspects of late.”Certainly, there’s no shortage of issues to point to: a slowing of the U.S. economy; the fiscal cliff; U.S. election uncertainty; continuing debt woes in Europe; and decelerating demand and output from Asia.

In addition, he noted that diesel prices spiked in July through mid-September (up 13% in 11 weeks), “causing a material headwind for many capacity providers (particularly for trucking and the rails) due to the fuel surcharge lag.

“The culmination of these developments restrained overall consumption growth and capital and inventory investment, driving the softer-than-expected freight trends,” he summed up. “We believe the softening volumes have also led to overcapacity, particularly in air and trucking, driving spot prices lower.”

This year’s 3Q may not have turned out so hot, given what Nesvold has turned up. However, looking further out via the latest FTR Associates’ Trucking Conditions Index (TCI) indicates that trucking conditions are expected to improve in 2013 “because of modestly better economics and a strong increase in capacity utilization stemming from added constraints on trucking from Federal regulations taking effect in mid-year 2013.”

FTR’s TCI is a compilation of factors affecting trucking companies. Any reading above zero indicates a positive environment for trucking; readings above 10 signal that volumes, prices, and margins are in a solidly favorable range. This latest TCI (August) rose 1.4 points (from July) to a reading of 5.8.

“Setting aside the inherent economic risks at the moment, we expect the rate environment to improve for fleets as capacity tightens in 2013 when more stringent Hours-of-Service [HOS] rules go into effect,” explained Jonathan Starks, FTR’s director of transportation analysis.

“ This will also have the effect of worsening the driver shortage, moving the situation from the currently ‘tight-but-manageable’ level towards a more acute shortage, similar to that experienced back in 2004, when the last major rule change went into effect,” he continued.

“Importantly,” Starks advised, “truck fleets will also need to keep a keen eye on the economic environment heading into 2013 because a major downshift in growth would have major negative implications on margins just as the new ‘tranche’ of HOS regulations go into effect.”

Backing up FTR’s 2013 outlook are recent remarks by Bob Costello, chief economist for the American Trucking Assns. He said during a presentation late last month that barring inaction on the Fiscal Cliff and no overwhelming impact from the Eurozone financial crisis, the U.S. economy will continue to grow into next year, albeit at a “modest pace.”

More specifically, Costello forecast that U.S. gross domestic product (GDP) will grow an average of just 1.5% through the rest of this year and on into next. He said GDP “won't get to 2% growth until the 3rd quarter of next year."

FTR Associates also just released preliminary data showing September Class 8 truck net orders at 15,205, which is down slightly from August. The firm said Sept. ‘12 orders were 35% below the same month last year-- contributing to the weakest quarter since 3Q:10. What’s more, the annualized rate for net orders placed in 3Q:12 came in at just 174,400 units.

“September orders were at the low end of our expectations so they were somewhat disappointing,” remarked FTR president Eric Starks.

“We wouldn’t have been surprised to see three to four thousand more units ordered in the month,” he continued, “but the reported numbers were certainly within the range we expected to see, albeit softer than we would have liked.

“Even with sluggish freight levels,” Starks added, “we still expect to see a seasonal bounce in orders during 4Q, but likely not at levels that many in the industry are hoping to see.”